PROBLEMS ARISING FROM GROWTH

Diseconomies of Scale

Diseconomies of scale may occur if a business expands that scale of its operations further than
the minimum efficient scale. This is where long-run average costs rise as output rises.

Sources of diseconomies of Scale

There are a number of reasons why long-run average costs might rise as output is pushed above
the minimum efficient scale. They fall into two groups- internal diseconomies of scale and
external diseconomies of scale.

 Internal diseconomies of scale: Internal diseconomies of scale are rising costs

caused by excessive growth in the business. Most internal diseconomies are caused
by the problem of managing very large business organizations.
 Poor communication: Very large firms suffer from poor communication. The
flow of information between individual employees, departments, division or
between head office and subsidiaries becomes more difficult to manage when a firm
is very large. This is because the chain of command in such organizations may be
long. Both internal and external communication might be affected. In a very large
organization it is possible to lose touch with customers and as a result a business
may fail to identify changes in customer needs.
 Control and co-ordination: The control and co-ordination of large businesses is
also demanding. Thousands of employees, large amounts of resources and many
different operational locations all mean added responsibility and more supervision.
In many cases, businesses have to employ a larger number of managers and
supervisors a larger number of managers and supervisors to maintain adequate
control. This can result in rising costs.
 Poor worker motivation: Motivation may suffer as individual workers become a
minor part of the total workforce. In an organization that employs thousands of
people globally, each individual worker may feel unimportant. There may be
higher levels of staff turnover, increased absence and poor time-keeping, which will
raise labour costs. There may also be poor relations between management and
workforce in a very large organization.
 Technical diseconomies: Plants, machinery and equipment will usually have an
optimum capacity. If these resources are overused, they are likely to become
inefficient. The engine may run ‘too hot’, causing it to stop working properly. This
might reduce its output or result in a breakdown which will cost money to repair. If
a business employs one huge plant and a breakdown occurs production will stop.
With two smaller plants, production can continue even if one breaks down.

COURSE INSTRUCTOR: ABU NAYEEM MOHAMMED SUYEEB

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  Bureaucracy: If a business too bureaucratic, it means that too many resources are
used in administration. Too much time may be spent filling in forms or writing
reports. Decision making could take too long because communication channels are
too long. If resources are wasted in administration average costs will start to rise.

External diseconomies of scale

External diseconomies occur when an industry grows too big. Rapid growth in an industry can
result in the price of production factors rising sharply. This is because growing demand for them
drives up the price. External diseconomies are perhaps occurring when an industry grows in the
same geographical location. The price of land, labour, services and materials might rise as firms
compete with each other in the same area for a limited amount of resources.

Also, congestion in the area might lead to inefficiency as delays are caused to deliveries and
employees travelling to work. Duplication of resources may occur when there are two or more
identical activities or projects are being followed in the same organization. Different departments
compete for company resources they may adopt a ‘silo mentality’. This is where individual
departments become reluctant to share information with others in the organization. This behavior
could lead to conflict between departments and even missed opportunities and higher costs.

Internal Communication

Internal communication is the exchange of messages and the flow of information inside a
business. If a business grows too big, there could be a problem with internal communication.
This is because the number of layers in the management structure is likely to grow. As a result,
channels of communication get longer and the scope for error in sharing messages increases.
This reduces productivity.
With the rapid development in information and communication technology (ICT), some
of these problems may have been reduced.

Overtrading

Overtrading occurs when a business tries to fund a large volume of new business with sufficient
resources. As a result, it runs out of cash and at worst, it can collapse. If a business grows too
fast, there is a danger that it might suffer from overtrading. Young, rapidly growing businesses
are more likely to affect. Reason why overtrading occurs:-

 Does not have enough capital. It is common for new businesses to be undercapitalized. It
means, it started trading with insufficient capital and does not have enough resources to
meet the growing orders.
 Offers too much trade credit to customers. It is tempting for a new business to allow its
customer 90 or 120 days’ trade credit. But this means business has to wait for a long

COURSE INSTRUCTOR: ABU NAYEEM MOHAMMED SUYEEB

CONTACT: +8801752408560
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 time to be paid. For this reason there will be short of cash to buy new resources to meet
new orders.
 In order to make an impact in the market, a new business may offer its products at lower
prices. However, with lower profit, it may not generate enough profit to fund the
growing volume of business.

Whatever the cause, if a business is overtrading it can run out of cash and this threatens its
survival. Therefore, growth has to be managed carefully.

COURSE INSTRUCTOR: ABU NAYEEM MOHAMMED SUYEEB

CONTACT: +8801752408560
EMAIL: suyeebnayeem@gmail.com